SEC Filing | Psychemedics Corporation

1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) X QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF THE - --- SECURITIES EXCHANGE ACT OF 1934 For quarterly period ended JUNE 30, 1998 TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ________________ to ________________ Commission file number 1-13738 PSYCHEMEDICS CORPORATION (exact name of Issuer as specified in its charter) Delaware 58-1701987 (State or other jurisdiction of (I.R.S. Employer incorporation of organization) Identification No.) 1280 Massachusetts Ave., Suite 200, Cambridge, MA 02138 (Address of principal executive offices) (Zip Code) Issuer's telephone number, including area code (617-868-7455) Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15 (d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- Number of shares outstanding of only class of Issuer's Common Stock as of August 10, 1998: Common Stock $.005 par value (22,253,698 shares). 1

2 PSYCHEMEDICS CORPORATION Part I FINANCIAL INFORMATION PAGE NO. Item 1 Financial Statements Condensed Balance Sheets as of June 30, 1998 and December 31, 1997 3 Condensed Statements of Income for the three month periods ended June 30, 1998 and 1997 4 Condensed Statements of Income for the six month periods ended June 30, 1998 and 1997 5 Condensed Statements of Cash Flows for the six month periods ended June 30, 1998 and 1997 6 Notes to Condensed Financial Statements 7-8 Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations 9-12 Part II OTHER INFORMATION Item 4 Submission of Matters to a Vote of Security Holders 13 Item 6 Exhibits and Reports on Form 8-K 13 SIGNATURES 14 2

3 PSYCHEMEDICS CORPORATION CONDENSED BALANCE SHEETS (UNAUDITED) JUNE DECEMBER 30, 1998 31, 1997 ------------ ------------ ASSETS CURRENT ASSETS Cash and cash equivalents $ 27,583 $ 585,142 Short-term investments 9,689,512 9,446,418 Accounts receivable 4,024,946 3,784,488 Inventories 382,345 500,325 Prepaid expenses and other current assets 1,210,906 895,874 ------------ ------------ Total current assets 15,335,292 15,212,247 ------------ ------------ PROPERTY AND EQUIPMENT Equipment and leasehold improvements, at cost 7,441,036 6,241,516 Less-Accumulated depreciation and amortization (3,450,755) (3,021,842) ------------ ------------ 3,990,281 3,219,674 ------------ ------------ OTHER ASSETS - NET 436,289 423,318 ============ ============ $ 19,761,862 $ 18,855,239 ============ ============ LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable $ 140,105 $ 196,259 Accrued expenses 986,734 438,063 Deferred revenue 1,624,504 1,488,010 ------------ ------------ Total current liabilities 2,751,343 2,122,332 ------------ ------------ SHAREHOLDERS' EQUITY Preferred stock, $.005 par value; authorized 1,000,000 shares; none outstanding Common stock; $.005 par value; authorized 50,000,000 shares; issued 22,518,345 and 22,382,720 shares in 1998 and 1997, respectively 112,592 111,913 Paid-in capital 23,902,397 23,581,549 Accumulated deficit (5,227,615) (5,537,505) Less - Treasury stock, at cost; 248,447 and 183,683 shares in 1998 and 1997, respectively (1,345,450) (1,005,439) Less - Receivable from officer (431,405) (417,611) ------------ ------------ Total shareholders' equity 17,010,519 16,732,907 ------------ ------------ $ 19,761,862 $ 18,855,239 ============ ============ See accompanying notes to financial statements and management's discussion and analysis of financial condition and results of operations. 3

4 PSYCHEMEDICS CORPORATION CONDENSED STATEMENTS OF INCOME (UNAUDITED) THREE MONTHS ENDED JUNE 30, ----------------------------- 1998 1997 ----------- ----------- REVENUE $ 4,834,720 $ 4,402,203 DIRECT COSTS 1,910,326 1,606,615 ----------- ----------- Gross profit 2,924,394 2,795,588 ----------- ----------- EXPENSES: General and administrative 768,892 563,049 Marketing and selling 865,737 1,124,003 Research and development 113,854 110,174 ----------- ----------- 1,748,483 1,797,226 ----------- ----------- OPERATING INCOME 1,175,911 998,362 OTHER INCOME 141,872 131,214 ----------- ----------- NET INCOME BEFORE INCOME TAXES 1,317,783 1,129,576 PROVISION FOR INCOME TAXES 535,597 384,056 ----------- ----------- NET INCOME $ 782,186 $ 745,520 =========== =========== BASIC NET INCOME PER SHARE $ 0.04 $ 0.03 =========== =========== DILUTED NET INCOME PER SHARE $ 0.03 $ 0.03 =========== =========== WEIGHTED AVERAGE COMMON SHARES OUTSTANDING 22,231,158 21,832,664 =========== =========== WEIGHTED AVERAGE COMMON SHARES OUTSTANDING, ASSUMING DILUTION 22,676,094 22,797,637 =========== =========== See accompanying notes to financial statements and management's discussion and analysis of financial condition and results of operations. 4

5 PSYCHEMEDICS CORPORATION CONDENSED STATEMENTS OF INCOME (UNAUDITED) SIX MONTHS ENDED JUNE 30, ----------------------------- 1998 1997 ----------- ----------- REVENUE $ 8,956,623 $ 7,655,947 DIRECT COSTS 3,605,214 2,928,487 ----------- ----------- Gross profit 5,351,409 4,727,460 ----------- ----------- EXPENSES: General and administrative 1,376,858 1,095,703 Marketing and selling 1,633,759 1,781,446 Research and development 220,847 219,082 ----------- ----------- 3,231,464 3,096,231 ----------- ----------- OPERATING INCOME 2,119,945 1,631,229 OTHER INCOME 278,256 256,806 ----------- ----------- NET INCOME BEFORE INCOME TAXES 2,398,201 1,888,035 PROVISION FOR INCOME TAXES 974,737 505,408 ----------- ----------- NET INCOME $ 1,423,464 $ 1,382,627 =========== =========== BASIC NET INCOME PER SHARE $ 0.06 $ 0.06 =========== =========== DILUTED NET INCOME PER SHARE $ 0.06 $ 0.06 =========== =========== WEIGHTED AVERAGE COMMON SHARES OUTSTANDING 22,220,804 21,866,699 =========== =========== WEIGHTED AVERAGE COMMON SHARES OUTSTANDING, ASSUMING DILUTION 22,686,146 22,807,787 =========== =========== See accompanying notes to financial statements and management's discussion and analysis of financial condition and results of operations. 5

6 PSYCHEMEDICS CORPORATION CONDENSED STATEMENTS OF CASH FLOWS (UNAUDITED) SIX MONTHS ENDED ENDED JUNE 30, ------------------------------ 1998 1997 ----------- ----------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 1,423,464 $ 1,382,627 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 460,453 286,976 Changes in assets and liabilities: Receivables (252,421) (1,473,679) Inventories 117,980 (198,595) Prepaid expenses and other current assets (315,032) (429,682) Accounts payable (56,154) 273,957 Accrued expenses 548,671 95,813 Deferred revenue 136,494 873,165 ----------- ----------- Net cash provided by operating activities 2,063,455 810,582 ----------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES: Net purchases of short-term investments (243,094) (250,896) Purchases of property and equipment (1,199,520) (887,536) (Increase) decrease in other assets - net (44,512) 12,592 ----------- ----------- Net cash used in investing activities (1,487,126) (1,125,840) ----------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES: Net proceeds from the issuance of common stock 319,696 910,297 Cash dividends paid (1,113,573) (1,312,667) Acquisition of treasury stock (340,011) - ----------- ----------- Net cash used in financing activities (1,133,888) (402,370) ----------- ----------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (557,559) (717,628) CASH AND CASH EQUIVALENTS, beginning of period 585,142 1,462,678 ----------- ----------- CASH AND CASH EQUIVALENTS, end of period $ 27,583 $ 745,050 =========== =========== See accompanying notes to financial statements and management's discussion and analysis of financial condition and results of operations. 6

7 PSYCHEMEDICS CORPORATION NOTES TO FINANCIAL STATEMENTS June 30, 1998 1. Interim Financial Statements The accompanying unaudited interim financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission for reporting on Form 10-Q. Accordingly, certain information and footnote disclosure required for complete financial statements are not included herein. It is recommended that these financial statements be read in conjunction with the financial statements and related notes of Psychemedics Corporation (the "Company") as reported in the Company's Annual Report on Form 10-K for the year ended December 31, 1997. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation of financial position, results of operations, and cash flows at the dates and for the periods presented have been included. The balance sheet presented as of December 31, 1997 has been derived from the financial statements that have been audited by the Company's independent public accountants. The results of operations for the three months and the six months ended June 30, 1998 may not be indicative of the results that may be expected for the year ending December 31, 1998, or any other period. 2. Basic and Diluted Net Income Per Share In March 1997, the Financial Accounting Standards Board (FASB) issued SFAS No. 128, Earnings Per Share. This statement established standards for computing and presenting earnings per share. Net income per share for each period presented has been retroactively restated to conform to SFAS No. 128. Basic net income per share was computed by dividing net income by the weighted average number of common shares outstanding during the period. Diluted net income per share was computed by dividing net income by the weighted average number of common and dilutive common equivalent shares outstanding during the period. Dilutive common equivalent shares outstanding during the period have been determined in accordance with the treasury-stock method. Common equivalent shares consist of common stock issuable upon the exercise of outstanding options. Basic and diluted weighted average common shares outstanding are as follows: Three Months Ended Six Months Ended --------------------------- --------------------------- 6-30-98 6-30-97 6-30-98 6-30-97 ---------- ---------- ---------- ---------- Weighted average common shares 22,231,158 21,832,664 22,220,804 21,866,699 Effect of dilutive common stock options 444,936 964,973 465,342 941,088 ---------- ---------- ---------- ---------- Weighted average common shares outstanding, assuming dilution 22,676,094 22,797,637 22,686,146 22,807,787 7

8 PSYCHEMEDICS CORPORATION NOTES TO FINANCIAL STATEMENTS For the three months ended June 30, 1998 and 1997, options to purchase 558,316 and 50,000 common shares, respectively, were outstanding but not included in the diluted weighted average common share calculation as the effect would have been antidilutive. For the six months ended June 30, 1998 and 1997, options to purchase 542,866 and 50,000 common shares, respectively, were outstanding but not included in the diluted weighted average common share calculation as the effect would have been antidilutive. 3. Revenue Recognition Revenues for all product offerings are recognized upon reporting drug test results to the customer. During the second quarter of 1997, the Company began offering its personal drug testing service, "PDT-90" through retail drug stores. At June 30, 1998 and December 31, 1997, the Company had approximately $1,625,000 and $1,488,000, respectively, of deferred revenue related to the PDT-90 service, principally due to receiving payments prior to the performance of the related test. 4. New Accounting Pronouncements Effective January 1, 1998, the Company adopted the provisions of SFAS No.130, Reporting Comprehensive Income. SFAS No. 130 requires disclosure of all components of comprehensive income on an annual and interim basis. Comprehensive income is defined as the change in equity of a business enterprise during a period from transactions and other events and circumstances from nonowner sources. The Company's total comprehensive income for the three and six month periods ended March 31, 1998 and June 30, 1998 was the same as reported net income. In March 1998, the American Institute of Certified Public Accountants ("AICPA") issued Statement of Position (SOP) 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use. SOP 98-1 requires computer software costs associated with internal use software to be expensed as incurred until certain capitalization criteria have been met. The Company will adopt SOP 98-1 prospectively beginning January 1, 1999. Adoption of this Statement is not expected to have a material impact on the Company's financial position or results of operations. In April 1998, the AICPA issued SOP 98-5, Reporting on the Costs of Start-Up Activities. SOP 98-5 requires all costs associated with pre-opening, pre-operating and organization activities to be expensed as incurred. The Company will adopt SOP 98-5 beginning January 1, 1999. Adoption of this Statement is not expected to have a material impact on the Company's financial position or results of operations. 8

9 Item 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FACTORS THAT MAY AFFECT FUTURE RESULTS From time to time, information provided by the Company or statements made by its employees may contain "forward-looking" information which involves risks and uncertainties. In particular, statements contained in this report which are not historical facts (including but not limited to the Company's expectations regarding revenues, business strategy, anticipated operating results, cash dividends and anticipated cash requirements) may be "forward looking" statements. The Company's actual results may differ from those stated in any "forward looking" statements. Factors that may cause such differences include, but are not limited to, risks associated with the continued expansion of the Company's sales and marketing network, development of markets for new products and services offered by the Company, the economic health of principal customers of the Company, financial and operational risks associated with possible expansion of testing facilities used by the Company, government regulation (including, but not limited to, Food and Drug Administration regulations), competition and general economic conditions. OVERVIEW Psychemedics Corporation was incorporated in 1986. The Company utilizes a patented hair analysis method involving radioimmunoassay technology to analyze human hair to detect abused substances. The founder of the Company has granted to the Company an exclusive license to all his rights in this hair analysis technology, including his rights to the drug extraction method. RESULTS OF OPERATIONS Revenue was $4,834,720 in the second quarter of 1998 as compared to $4,402,203 in the second quarter of 1997, representing an increase of 10%. Revenue for the six month period ended June 30, 1998 was $8,956,623, an increase of 17% over the $7,655,947 of revenue reported for the comparable period of 1997. The revenue increase was due primarily to increases in volume from both new and existing clients offset by average price decreases of 1% primarily as a result of volume discounts granted to large customers. Gross margin was 60% of sales in the second quarter of 1998, as compared to 64% in the year earlier period. Gross margin was 60% for the six months ended June 30, 1998 as compared to 62% in the year earlier period. The decreases in 1998 can be attributed to the average price decrease of 1% and the fact that although revenue increased for the three month period and the six month period ended June 30, 1998 when compared to the year earlier periods, the Company had anticipated that the demand for its services would be greater and had increased its production capacity accordingly. 9

10 General and administrative ("G&A") expenses were $768,892 for the three months ended June 30, 1998 as compared to $563,049 for the three months ended June 30, 1997, representing an increase of 37%. G&A expenses were $1,376,858 for the six months ended June 30, 1998 as compared to $1,095,703 for the year earlier period, representing an increase of 26%. As a percentage of revenue, G&A expenses increased to 16% in the second quarter of 1998 from 13% in the second quarter of 1997 and increased to 15% for the six months ended June 30, 1998 from 14% for the comparable year earlier period. Approximately half of the increases were personnel related and consisted primarily of three additions to staff, costs pertaining to the introduction of a 401(k) retirement plan, and costs associated with employee turnover in the finance department. The Company's activities relating to investor relations and greater professional fees also contributed to the increases. Marketing and selling expenses for the three month period ended June 30, 1998 decreased $258,266 to $865,737, a decrease of 23%. Marketing and selling expenses were $1,633,759 for the six months ended June 30, 1998 as compared to $1,781,446 for the year earlier period, representing a decrease of 8%. Total marketing and selling expenses decreased as a percentage of revenue from 26% in the second quarter of 1997 to 18% in the second quarter of 1998, and decreased as a percentage of revenue from 23% for the six months ended June 30, 1997 to 18% for the six months ended June 30, 1998. Although the Company continued to expand marketing activities related to the corporate market in 1998, total marketing and selling expenses decreased from 1997 levels because a significant amount of expenditures made in the second quarter of 1997 to initially penetrate the retail home testing market were non-recurring. Other income for the three month and the six month periods ended June 30, 1998 represented primarily interest earned on cash equivalents and short-term investments. The increase in 1998 was primarily due to higher investment balances coupled with increased yields on these investments. Net income before income taxes increased by $188,207 to $1,317,783 and by $510,166 to $2,398,201 for the three months and six months ended June 30, 1998, respectively, when compared to the year earlier periods. Net income was $782,186 for the second quarter of 1998 as compared to $745,520 for the second quarter of 1997. Net income for the six months ended June 30, 1998 was $1,423,464 as compared to $1,382,627 for the year earlier period. The effective tax rate for the three month and the six month periods ended June 30, 1998 was 41% in 1998 versus 34% and 27% for the three month and the six month periods ended June 30, 1997, respectively. This increase in the effective tax rate reflects the reduction in net operating loss carryforwards available to offset the provision for income taxes for financial reporting purposes. LIQUIDITY AND CAPITAL RESOURCES At June 30, 1998, the Company had $9.7 million of cash, cash equivalents and short-term investments. The Company's operating activities generated net cash of $2,063,455 in the six months ended June 30, 1998. Investing activities used $1,487,126 in the six month period while financing activities used a net amount of $1,133,888 during the period. 10

11 The Company's source of funds in the first six months of 1998 was derived almost entirely from cash generated from operations. Operating cash flows increased $1,252,873 in the first two quarters of 1998, compared to the year earlier period. Net income increased by $40,837 compared to the 1997 period, and along with a decrease in inventories and an increase in accrued expenses for the six months ended June 30, 1998 contributed to cash flow. Increases in receivables, prepaid expenses and other current assets and a decrease in accounts payable offset this to a lesser degree. Also, deferred revenue, which represents deliveries to retail outlets of the Company's retail product PDT-90, increased by $136,494. The non-cash effect of depreciation and amortization in the 1998 and 1997 periods was $460,453 and $286,976, respectively. Capital expenditures in the first two quarters of 1998 were $1,199,520. The expenditures primarily consisted of new equipment, including laboratory and computer equipment. The Company believes that within the next two years it may be required to expand its existing laboratory or develop a second laboratory, the cost of which is currently believed to range from $2 million to $4 million. During the six month period ended June 30, 1998, the Company distributed $1,113,573 in cash dividends to its shareholders. At June 30, 1998, the Company's principal sources of liquidity included an aggregate of $9.7 million of cash, cash equivalents and short-term investments. Management currently believes that such funds, together with cash generated from operations, should be adequate to fund anticipated working capital requirements and capital expenditures in the near term. Depending upon the Company's results of operations, its future capital needs and available marketing opportunities, the Company may use various financing sources to raise additional funds. Such sources could potentially include joint ventures, issuance of common stock or debt financing. At June 30, 1998, the Company had no long-term debt. IMPACT OF YEAR 2000 ISSUE The Year 2000 issue results from computer programs written using two digits rather than four to define the applicable year. Any of the Company's computer programs that have date-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a system failure or miscalculations causing disruptions of operations, including, among other things, a temporary inability to process transactions, send invoices, or engage in similar normal business activities. The Company is in the process of conducting an assessment of its computer information systems and is beginning to take the necessary steps to determine the nature and extent of the work required to make its systems Year 2000 compliant, where necessary. These steps will require the Company to modify, upgrade or replace some of its internal financial and operational systems. The Company continues to evaluate the estimated cost of bringing all internal systems, equipment and operations into Year 2000 compliance, but has not yet finished determining the total cost of these compliance efforts. While these efforts will involve additional costs, the Company believes, based upon currently available information, that these costs will not have a material adverse effect on its business, financial condition or results of operations. However, if these efforts are not completed on time, or if the cost of updating or replacing the Company's information systems exceeds the Company's current estimates, the Year 2000 issue could have a material adverse impact on the Company's business, financial condition or results of operations. 11

12 The Company also intends to determine the extent to which the Company may be vulnerable to any failures by its major suppliers, distributors and service providers to remedy their own Year 2000 issues, and is in the process of initiating formal communications with these parties. At this time the Company is unable to estimate the nature or extent of any potential adverse impact resulting from the failure of third party suppliers, distributors and service providers to achieve Year 2000 compliance, although the Company does not currently anticipate that it will experience any material shipment delays from its major product suppliers or any material sales delays from its major distributors due to Year 2000 issues. However, there can be no assurance that these third parties will not experience Year 2000 problems or that any problems would not have a material effect on the Company's product supply and distribution channels. Because the cost and timing of Year 2000 compliance by third parties such as suppliers, distributors and service providers is not within the Company's control, no assurance can be given with respect to the cost or timing of such efforts or any potential adverse effects on the Company of any failure by these third parties to achieve Year 2000 compliance. 12

13 PART II OTHER INFORMATION Item 4. Submission of Matters to a Vote of Security Holders The Annual Meeting of Shareholders of Psychemedics Corporation was held on May 4, 1998 for the purpose of electing a board of directors and approving the appointment of the Company's auditors. Proxies for the meeting were solicited pursuant to Section 14(a) of the Securities Exchange Act of 1934 and there was no solicitation in opposition to management's solicitations. A brief description of each matter voted upon at the meeting and tabulation by the Company's transfer agent of the vote cast with respect to each matter is included as Exhibit 22 to this Form 10-Q. Item 6. Exhibits and Reports on Form 8-K (a) Exhibits. 22. Submission of Matters to a Vote of Security Holders 27. Financial Data Schedule (b) Reports on Form 8-K No reports on Form 8-K were filed during the quarter for which this report is filed. 13

14 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Psychemedics Corporation Date: August 10, 1998 By: /s/ Raymond C. Kubacki, Jr. ------------------------------------- Raymond C. Kubacki, Jr. President and Chief Executive Officer Date: August 10, 1998 By: /s/ Peter C. Monson -------------------------------------- Peter C. Monson Vice President, Treasurer & Controller (principal financial officer) 14

1 Exhibit 22 22. Submission of Matters to a Vote of Security Holders Description and tabulation by the Company's transfer agent of each matter voted upon at the Annual Meeting of Shareholders of Psychemedics Corporation held on May 4, 1998. All of management's nominees for directors, as listed in the proxy statement, were elected with the following vote: Election of Directors. NUMBER OF SHARES ---------------- FOR WITHHELD AUTHORITY --- ------------------ Werner A Baumgartner, Ph.D. 19,236,158 99,363 Donald F. Flynn 19,243,308 92,213 Raymond C. Kubacki, Jr. 19,233,428 102,093 John J. Melk 19,243,308 92,213 A. Clinton Allen 19,240,578 94,943 Fred J. Weinert 19,240,063 95,458 Selection of Arthur Andersen LLP as auditors of the Company. NUMBER OF SHARES ---------------- For 19,238,659 Against 28,066 Abstain 68,796

5 6-MOS DEC-31-1998 JUN-30-1998 27,583 9,689,512 4,024,946 0 382,345 15,335,292 7,441,036 3,450,755 19,761,862 2,751,343 0 0 0 112,592 16,897,927 19,761,862 8,956,623 8,956,623 3,605,214 3,605,214 3,231,461 0 0 2,398,201 974,737 1,423,464 0 0 0 1,423,464 0.06 0.06